Just before Christmas, top managers of Telefonica SA (TEF) gathering in a Madrid cinema tried to remain upbeat after a year in which the company had scrapped its dividend and sold off assets. While they were quick to point out that those steps had stabilized the company’s finances, they couldn’t avoid the bad news in their biggest market, Spain.
Luis Miguel Gilperez, the head of Spanish unit, told the audience of 500 that with sales in Telefonica’s home country tumbling as customers defect to low-cost competitors, managers need to step up efforts to jump-start growth.
He said Europe’s most indebted phone company must continue rolling out services introduced last year to fend off cheaper rivals -- all with diminished resources, according to two people at the event who asked not to be named because the meeting was private.
“We are in for a long period of austerity in Spain, still the company’s main market, and that will affect the group’s earnings,” Henri Alexaline, a fixed-income investor who helps manage $1 billion at FM Capital Partners Ltd. in London. “I would not be too bullish.”
Spain’s biggest telecommunications companies are struggling to stop a decline in revenue as the country’s unemployment rate has surged past 25 percent. In its latest attempt to prevent customers from switching to cheaper rivals such as Jazztel Plc (JAZ), Telefonica in October introduced “Movistar Fusion,” a bundle of voice, broadband and pay TV starting at 50 euros monthly.
That prompted similar moves by Vodafone Group Plc (VOD) and France Telecom SA (FTE)’s Orange Spain unit. Telefonica lost 284,290 mobile-phone customers in Spain in October, bringing its market share down to 36.8 percent, according to telecoms regulator CMT. That compares with market share gains by Orange and TeliaSonera AB (TLSN)’s Yoigo.
Most people joining Fusion seem to be existing customers seeking bargains, which hurts profit margins, said German Garcia, an analyst at Ahorro Corp. Financiera in Madrid. More price cuts aimed at halting customer losses would “seriously hamper profitability,” he said.
“Despite all the asset disposals and debt-cutting last year,” Garcia said, “the company needs to turn around weakening earnings in Spain, which remains its Achilles’ heel.”
Vodafone, the second-biggest mobile operator in Spain, plans to reduce its workforce of about 4,300 by as many as 900 after service revenue dropped 11 percent in the six months through September. The plan follows Telefonica’s decision to cut its workforce in Spain to 27,000 by year-end, down from 35,000 in 2011.
“Our headquarters are in Spain and we are exposed to the macroeconomic situation, both in the share price and spreads,” Chief Operating Officer Jose Maria Alvarez-Pallete told reporters in London today. “However, we are getting the perception that things may start to improve soon.”
The company, scheduled to report full-year earnings Feb. 28, is on track to meet its financial targets, Alvarez-Pallete said. “Even if we have regained significant financial flexibility, we still need to continue to deleverage.”
Efforts to cut debt helped ease the pain for Telefonica investors. In the second half, its shares slid 1.7 percent, outperforming Vodafone’s 14 percent drop and France Telecom’s 20 percent decline. London-based BT Group Plc (BT/A) led the former European monopoly carriers with a 9 percent gain for the period.
Telefonica dropped 0.5 percent to 10.94 euros at 1:48 p.m. in Madrid. Vodafone fell 1.9 percent to 159.95 pence in London.
Analysts are divided on Telefonica stock, with 16 recommendations each for “buy” and “hold” and 13 “sells.”
While Telefonica might once have looked to Latin America to bolster profits, that’s going to be tougher this year. In the third quarter, earnings in the region rose 4.8 percent to 2.7 billion euros as sales gained 3.8 percent. That compares with second-quarter revenue growth of 5.8 percent.
Latin America “is not the bright spot it used to be 12 or 18 months ago,” said Heinrich Ey, telecoms analyst at Allianz Global Investors in Frankfurt, which manages about 300 billion euros including Telefonica shares.
Still, the company is confident that the region will continue to expand. “There’s a lot of room for growth in Latin America in many fronts,” Alvarez-Pallete said today.
During the past 12 months, Chief Executive Officer Cesar Alierta canceled dividends and share buyback plans for 2012, cutting a revenue forecast and slashing salaries for top executives. As compensation for investors, the carrier has pledged to pay 75 euro cents in two tranches by the end of 2014.
Alierta sold a stake in China Unicom (Hong Kong) Ltd. in July and call-center unit Atento five months Later. In October, Telefonica spun off its German business, raising $1.9 billion. That helped the company cut its debt to 52.8 billion euros from 58.3 billion euros in June. Its target for end of 2012 is about 50 billion euros, Finance Chief Angel Vila told investors in November.
Telefonica’s net debt at the end of the third quarter was 2.84 times earnings before interest, tax, depreciation and amortization, according to data compiled by Bloomberg. That’s the second highest among European phone companies, behind only Portugal Telecom SGPS SA (PTC), which had 7.8 billion euros in net debt, or 3.49 times its Ebitda.
To raise more cash, the company is considering an initial public offering of its Latin American business, though no final decision has been made, Alvarez-Pallete said today.
Alierta’s asset sales have helped Telefonica’s position in the credit market. On Jan. 8, it sold 1.5 billion euros of 10- year bonds, taking advantage of a rally that has pushed relative yields on corporate debt to the lowest level since January 2008. The cost of insuring Telefonica debt tumbled to an 18-month low, with credit-default swaps dropping to 206 basis points from a record 572.5 in June.
Nonetheless, Standard & Poor’s said last month it may reduce Telefonica’s BBB rating, the second-lowest investment grade, citing the company’s exposure to Spain’s sovereign-debt risks. Moody’s Investors Service ranks Telefonica’s long-term debt Baa2, the equivalent of S&P’s, with a negative outlook.
Telefonica still faces a “challenging” domestic situation, said Carlos Winzer, Moody’s lead analyst for Telefonica. “Despite Telefonica’s international diversification, the group’s exposure to the Spanish market puts it at risk given the weak macroeconomic conditions.”
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